I think that when people say "money is credit" they mean "money is created by borrowing it", an idea that I can and do accept. However, I always distinguish between money and credit because I need to distinguish between money that does, and money that does not, involve borrowing and repayment and interest. Surely there is a difference between money I receive in my paycheck and money I receive as a loan.
In addition, for this post, I need to distinguish between money used to make final payments, and money used when payment is deferred.
In my view:
- When you borrow money you receive credit (i.e., money plus the obligation to repay), and
- When you spend the borrowed money, the obligation to repay remains with you, and the recipient receives money, not credit.
In a long blog post I've been working on, I write
When you take out a loan and spend the money, or when you use your credit card, you are putting credit to use.I follow up on that thought a few lines later, saying
When you borrow and spend, or when you use a credit card, you are putting money into the economy.But this is not accurate. I could say
When you borrow and spend, or when you use a credit card, you add to total spending.That would be correct. But it doesn't allow me to make the next point that I want to make:
When you pay down a debt, you are taking money out of the economy.For my logic to be clear, I need to have the use of credit "put money in", and the repayment of debt "take money out". However, even though a loan does put the money into the economy when you spend it, using a credit card does not. The problem is that, by comparison to loans, credit cards represent an advance in financial innovation. Things happen differently with credit cards.
With loans, you decide you want one, and you go to the bank to make the arrangements. With credit cards, you take one out of your wallet and use it. There is even an chance that you received the credit card by mail, unsolicited. In this case it's clearly not your decision to take a loan. It's the credit card company betting that if you have the credit card, you'll use it. Essentially, they are giving you a loan even though you didn't ask for it. They are "nudging" you into the use of credit; and (as is typical with behavioral econ) the nudge too often works.
With loans, you have the money in your wallet or your checking account or in your high-tech version of one or the other, but you have the money, and when you spend the money it moves from your account to the account of the seller. You will still have to pay off the loan, yes. However, at this point the seller has been paid and your transaction with the seller is complete.
The process is different for credit cards. With credit cards, you have the credit card in your wallet. And when you use it an amount of credit is transferred from your account to the seller's account. The seller does not receive money, but rather credit -- a place-holder for money. Therefore, I cannot say
When you use a credit card, you are putting money into the economy.This topic came up recently in my Incomplete transactions post, where I quoted from The Evolution of Consumer Credit in America:
When a cardholder charged a meal, the restaurant sent the bill to Diners Club, and Diners Club then paid the price of the meal, minus a small commission, directly to the restaurant’s bank. Finally, Diners Club sent the cardholder a monthly statement (bill), and the cardholder sent Diners Club a check.That was the Diners Club innovation: It inserted itself between buyer and seller, created credit for everyone else to use, and took full charge of the payments of money.
Any chance creating that credit-card credit is a form of counterfeiting?
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Allow me to review and summarize.
Without a credit card, you first get the loan and then spend the money, and at that point the seller receives the money.
With a credit card, you create a new loan on the fly when you pay for your purchase, but the seller receives credit instead of money. An additional transaction is required, between the seller and the credit card company, for the seller to get the money.
Because of this financial innovation I am not able to say that putting credit to use puts money into the economy. Credit card use puts credit into the economy. So I have to stop and re-think things.
When I take a loan, I receive credit (money plus the obligation to repay). But when I use a credit card I receive only the obligation to repay. No money. (Plus I receive the thing I bought, but that's the original transaction and it happens with loans, with credit cards, and even with cash!)
When I spend the money I borrowed, the seller receives money. But when I use a credit card, the seller receives credit. So an additional transaction is required, where the seller exchanges the credit for money from the credit card company.
Either way, loan or credit card, I still have the obligation to repay, which also creates an additional transaction, this one between me and the credit card company.
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Let me condense these thoughts.
When I take a loan new money is created, and when I spend it the seller receives money.
When I use a credit card, new credit is created, and the seller receives credit. There is a follow-up transaction between the seller and the credit card company where the credit is exchanged for money. And there is a follow-up transaction between me and the credit card company where money is exchanged for credit, fulfilling my obligation to repay. However, both of these follow-up transactions occur after the initiating transaction is complete. Money is not used at all in the initiating transaction.
No money is created when a credit card is used. A possible exception is the use of a credit card to get cash. But the statement is true for purchases: No money is created when a credit card is used.
Hm.
Up top, I said:
- When you borrow money you receive credit (i.e., money plus the obligation to repay), and
- When you spend the borrowed money, the obligation to repay remains with you, and the recipient receives money, not credit.
- When you use a credit card you receive the obligation to repay (but no money), and
- The seller receives credit, not money.
- An additional transaction is required for the seller to exchange the credit for money.
The use of a credit card "puts credit in", and repaying the debt "takes credit out".
Okay. Maybe this is the reason J.W. Mason says
I don't think the idea of "money" as something that has a quantity applies to the credit-money world of todayand all that. Fair enough.
But there is something Mason's statement does not address: The growth of finance creates growing financial cost in our economy. And, since the financial and nonfinancial sectors are different and distinct, it is possible that growing financial cost can harm the nonfinancial economy.
More than just "possible" I think. I find it necessary that we reduce the size of finance in order to reduce the cost of finance. (Note that in credit card "follow-up" transactions both the buyer and the seller are likely to be paying interest or a "commission" to the credit card company.)
If it is necessary to reduce the cost of finance, which it is, then this "credit-money world of today" has got to go. We should cut credit-use by half, and by half again, and after that we'll see.
As always, it all comes down to policy. Don't let them forget it, either.
6 comments:
Interesting thoughts! Thank you for spending the time and effort to put into writing and share with the world!
I like your analysis of credit card transactions and, more generally, your ideas about incomplete transactions. I think you're on the scent of something profound and with broad implications.
(I also like that you bring the word "counterfeiting" into the discussion, although I suspect that the actions that you regard as counterfeiting might not be the same as those that I would regard as counterfeiting. I like you using the word because it helps us to think about what money is. If money is more than the banknotes of a central bank or the coins of a government treasury, then bad hair Benjamins exemplify only one specific form of counterfeiting. Contemplating counterfeiting also, I think, helps us understand how various bad actors damage an economy.)
I'm not sure that I agree entirely with how you understand money, although I suspect that our views are not too far apart. Please allow me to elaborate.
<< If you are someone who always says "money is credit" … >>
On the contrary, I am someone who always says that money is debt, or, to be more precise, that money is always someone else's promise to give value in future. I define money as someone else's negotiable (i.e., payable to the bearer) promise to give value, which I tender to a creditor of mine and which my creditor accepts as satisfaction of my debt. (If I wish to avoid incurring a debt, I might strike a bargain with a trading partner to accept such a negotiable promise as settlement of a spot transaction, that is, in exchange for value that the trading partner is giving me now.) While the "money" in the satisfaction of a debt (or the settlement of a spot trade) is properly the third party's promise, which my creditor (or trading partner) is accepting, I shall likely also call "money" the instrument, be it note, IOU, computer record, or whatever, that records the promise and allows it to be enforced. The money that I tender might be my debtor's own debt, which I propose to offset against my own debts to him, or might be a third party's debt, which my debtor intends either to tender to the third party, in satisfaction of his debts to the third party, or to trade onward to a fourth party creditor of his. I say that money is debt, rather than that money is credit, because neither I nor my payee is necessarily "crediting" the party whose promise, or debt, we are using in our transaction; it suffices that there is someone in the economy, at the end of a chain of transactions, who "credits" the issuer of the money, and then perhaps not even to deliver value, but simply not to deny the right of the one ultimately tendering the money to offset her own debts to the issuer.
<< I think that when people say "money is credit" they mean "money is created by borrowing it", an idea that I can and do accept. >>
Money is potentially created whenever a negotiable or assignable debt is created, that is, whenever someone makes a promise to give future value to whoever holds the note. The debt becomes money when the creditor assigns it to someone else to satisfy another debt (or to settle a spot transaction without incurring a debt). When a bank creates money by funding a loan with its own notes (nowadays not printed on high quality paper, but represented digitally in a high quality computer system), one might say that the money was created by borrowing it. When I purchase (with cash) a gift certificate from a popular restaurant and, before I can use it, give it to someone who accepts it as payment for an odd job that I unexpectedly and urgently needed done, I would say that, in creating money, the restaurant borrowed from me rather than I from the restaurant. When the U.S. government during the Civil War paid soldiers for their service and merchants for their goods in freshly printed greenbacks, surely the soldiers and merchants were lending their service and wares to the government, rather than borrowing money from it. So, I would say that money is sometimes created by borrowing it and sometimes not, but is always created by someone making a promise to give future value, whether by tendering goods or services, or by offsetting the money holder's debt.
<< Surely there is a difference between money I receive in my paycheck and money I receive as a loan. >>
I say that the transactions are different, but that the money is essentially the same. You accept your paycheck in satisfaction of the debt that your employer has incurred to you by you having given your labor. If your paycheck is a standard bank check against your employer's account, you are accepting as payment a contingent liability of your employer's bank. (If your paycheck is a cashier's check, you are accepting an unqualified liability of your employer's bank.) You will likely soon convert the contingent liability into either a liability of a Federal Reserve bank, by cashing the check, or into a liability of your bank, by depositing it. Regardless, you are accepting your paycheck in satisfaction of your employer's debt to you. When you borrow from your bank, you are entering into a spot exchange of debts: the bank is accepting your debt, recorded in the note that you sign and give to the bank, and is giving you in return its debt, recorded in virtual banknotes, which are physically represented by computer records that now show a greater balance in your checking account. Because the bank's debts are more liquid and less laden with credit risk than yours, you are giving more value in the exchange than the bank is giving you: you have agreed to pay more interest on your debt to the bank than the bank will pay on its debt to you.
<< When you borrow money you receive credit (i.e., money plus the obligation to repay) … >>
When you borrow money, you perform a spot exchange of debts: you give the bank your debt and the bank gives you its. You and the bank have both created money. (The bank's debt is more liquid and therefore more expensive than yours. This liquidity will likely quickly manifest, as you will likely soon trade the bank's debt onward for something else valuable to you. On the other hand, your debt, particularly after the bank's acceptance of it, is not entirely illiquid; the bank may well sell it to some other financial institution, or use it as collateral for borrowing in the money market.) If you borrow from a nonbank financial institution (perhaps even a pawnbroker or loan shark) rather than from a bank, you will likely receive in exchange for your debt not that institution's debt, but a Federal Reserve bank's; in that case, only you will have created money in the transaction.
<< When you spend the borrowed money, the obligation to repay remains with you, and the recipient receives money, not credit. >>
Let's say that you spend the borrowed money by writing checks. You continue to have a debt to your bank; your bank now has debts to the people holding your checks. If those people deposit the checks, their banks, through the check clearing process, will obtain payment from your bank (whose debt will thereby be extinguished) in Federal Reserve bank debts and will then issue their own private debt, in the form of higher balances in deposit accounts, to the people depositing the checks.
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Please pardon me for picking nits here. I believe that we have quite similar views about how money works and, more importantly, about some of the consequences of having a more "financialized" economy, which is to say, an economy in which more exchanges of real goods and services, rather than of financial assets, are, at any point in time, incomplete. I hope that my comments here about nuances of monetary mechanics will help bring us both to deeper insights.
飲中神仙 wrote:
Money is potentially created whenever a negotiable or assignable debt is created, that is, whenever someone makes a promise to give future value to whoever holds the note. The debt becomes money when the creditor assigns it to someone else to satisfy another debt (or to settle a spot transaction without incurring a debt).
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Minsky said anybody can create money, the problem is getting others to accept it as money.
The 2008 meltdown got people thinking about what money is and how money is created. The meltdown also revealed that trillions of dollars that people had been accepting as money suddenly became no longer accepted as money and the impact of that sudden loss of money supply is still something we are trying to crawl out from underneath.
Your analysis of what money is and how it is created is flawless as far as I can tell.
A word can have more than one definition. This is often convenient: My definition of money may be useful for some purposes, and yours for others, but that does not mean that either definition is incorrect. It would be incorrect to use my definition with your purpose, or your definition with my purpose. But that is a different matter.
Thank you, 飲中神仙, for your thoughts. Google Translate says your name means "Drinking fairy". A toast to you, then.
Let me start with the last part of your remarks. Your definition of a financialized economy is excellent (and I like that you work "incomplete" transactions into it). I think I will adopt your definition.
At the beginning of your remarks you write: "I think you're on the scent of something profound and with broad implications." Thank you, and thanks for noticing!
You write: "I am someone who always says that money is debt, or, to be more precise, that money is always someone else's promise to give value in future."
Okay. But I'm not sure why that matters. I accept Salerno and Pettinger's views that money is "the final means of payment in all transactions" and credit is "any form of deferred payment." Deferring payment leaves transactions incomplete. Payment of money completes them, but in the meantime there are financial costs.
I say debt is money that is owed. It is an amount, a measure of the incompleteness of transactions. Incomplete transactions almost universally require payment of interest and repayment of principal. I find it necessary to distinguish "money" from "debt" because of these cost differences.
As you say, you "believe that we have quite similar views about how money works and, more importantly, about some of the consequences of having a more "financialized" economy..." I agree that the consequences of financialization are more important than the details of how money works. As I said, "growing financial cost can harm the nonfinancial economy."
Your thoughts seem to be focused on the details of how money works. Mine are focused on the financial cost doing harm to our economy.
Again, focused on cost, I write: "I always distinguish between money and credit because I need to distinguish between money that does, and money that does not, involve borrowing and repayment and interest. Surely there is a difference between money I receive in my paycheck and money I receive as a loan."
You quote the last part of that, and say: "I say that the transactions are different, but that the money is essentially the same." To me, the difference between "money" and "credit" is the financial cost of the latter. I'm focused on financial cost.
You say: "You accept your paycheck in satisfaction of the debt that your employer has incurred to you by you having given your labor." I do, yes. I accept money in satisfaction of debt. And I therefore can only say that money and debt are different: Money is not debt.
I make distinctions between money and credit and debt. As Schumpeter said, if we do not make distinctions, "we shall never be able to say more than that everything depends upon everything."
You point out that "the bank's debts are more liquid and less laden with credit risk" than mine. And you point to this as the reason I have to pay interest on my debt (or, more interest than the bank pays me). Okay, that's interesting. It helps to explain why I have to pay interest on a loan. But again, it seems to me that you are focused on the details of how money works, while I am focused on the financial cost doing harm to our economy.
I am not saying that your details are wrong or incorrect, and they are certainly not fuzzy. But we are talking about different things, you and I. Therefore, my definitions differ from yours.
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You write: "When you borrow money, you perform a spot exchange of debts: you give the bank your debt and the bank gives you its. You and the bank have both created money."
Working together, the bank and I created the money that I borrowed. They put into my account. I got the money (and the obligation to repay). The bank didn't get money. The bank is going to get money later but that's not the same thing. That's deferred payment, or what Pettinger calls "credit".
On your definition ("money is always someone else's promise to give value in future") it is the same thing. But your definition is the wrong one for my purposes. I'm looking at the transaction level and you are not. Your focus is on the "someone in the economy, at the end of a chain of transactions, who "credits" the issuer of the money". If I understand the statement, your focus is on the institution; mine is on the transaction. And, as I always say, the economy is transaction.
By the way, the bank's use of my "less liquid debt" as money only makes it "near money", because it is less liquid. It happens, yes. But it happens in a highly financialized economy like ours, and it happens because we are highly financialized. If our reliance on credit was less, there would be less of it. That would be good, because the expansion of near money led to what Jim describes: "trillions of dollars that people had been accepting as money suddenly became no longer accepted as money".
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